Creative Estate Planning Uses for Life Insurance in 2021
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UPDATED: Jun 25, 2021
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Life Insurance can help your Estate Plan and we will show you some creative estate planning uses for life insurance.
“Nothing is certain except death and taxes.”
Although Benjamin Franklin uttered these famous words in 1787, they are all too true for us today.
In April, in the United States, folks all ponder taxes, and believe me, these are NOT pleasant thoughts!
But when one dies today, in our country, what estate taxes will their heirs be burdened with?
If their estate is of significant size, the burden might be very great.
One unique way to reduce the bitter sting of taxes due upon death is to use life insurance as part of a well-reasoned Estate Plan.
Will My Estate Owe Taxes? Who Pays It?
You might be wondering whether your estate will owe taxes, who pays it, and how it’s collected.
First of all, rest assured…
Fewer than 1% of estates will owe federal estate tax in 2019, and that’s because you can leave millions of dollars to your heirs before triggering a tax event. The exact amount you can leave is the “Federal Tax Exemption” amount, which we’ll cover in the next section.
If your estate does owe federal estate tax, however, it must be paid by your estate (via your executor or trustee) within 9 months of your passing.
If your estate is largely comprised of business or real estate, or other non-liquid assets, and it will owe taxes, that’s another great reason to consider life insurance. Life insurance provides quick, liquid cash that can be left to your estate (or a trust) to pay a tax bill that your estate otherwise might not be able to readily afford.
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Federal Estate Tax Exemption for 2019
Here’s the deal in 2019.
Each individual can pass away and leave an inheritance of up to $11.4 million (for married couples, it’s doubled to $22.8 million) without their heirs incurring any federal estate tax.
This is known as the “federal estate tax exemption” amount, and it changes (usually increases) just about every year.
Every dollar left to heirs over the exemption amount is currently taxed at 40%.
Pretty generous, right? We pay taxes on everything, but apparently very few of us will ever pay federal estate taxes if the exemption amounts stay this high!
Note: We’re talking about the Federal level.
(Taxes at the state level are separate – See our section below)
Where Life Insurance Fits Into Estate Taxes
It’s true, that with the current 2019 exemption of 11.4 million per person, only the very wealthy need to worry about Federal Estate Taxes – but at a whopping 40% tax rate, the wealthy should certainly make plans well in advance so their estate is not decimated by Federal Estate taxes!
If you are in this category, you don’t need me to tell you, as your attorney and accountant will have discussed these issues with you often.
However, if you have not yet utilized Life Insurance to help offset the impact of taxes on your estate, now would be a good time to consider it.
Why have your family come up with a massive tax payment if you could buy life insurance, and pay pennies on the dollar now to cover that payment?
You will never be younger than you are today, so the cost for Life Insurance to protect your estate will never be lower.
Estate Tax Considerations for Spouses
If you are married, then a Second-to-Die policy might be right for you – and is more cost-effective than two individual policies. Since no Estate Taxes are imposed until after the second spouse dies, this unique policy can make perfect sense.
Your attorney or tax professional will probably suggest an ILIT, which is an Irrevocable Life Insurance Trust that will purchase and own the life insurance policy so you will have no Incident of Ownership.
In this way, the death benefit will be kept out of your gross estate, leaving the funds available to pay your estate taxes.
Your non-liquid assets, such as stocks, bonds, and real property won’t have to be settled in a “fire sale” atmosphere, and so more of their value will be left intact. You may opt to use your annual gift-tax exclusion to fund the trust, knowing that those funds can only be used for untouchable Life Insurance premium
Don’t Compound Your Tax Problem with Life Insurance
In the previous section, we said you might want to take steps to avoid inclusion of life insurance proceeds in your taxable estate.
One caveat here…
Before you move to purchase such a life Insurance policy, it is important to understand how ownership in the policy is a critical determination.
For example, to avoid inclusion in your Federal estate, you need to have no Incident of Ownership – you must not be the owner of the policy, and must have no control over the policy of any kind. (Of course, you will want to discuss this with an attorney to make sure it’s done properly.)
It is also vital to select a strong life insurance company – not necessarily the one with the cheapest rates, but one with a stable history and good credit rating.
An independent life insurance agent can help you find the right carrier and the right product for your estate planning needs, and is just a click away!
State Estate & Inheritance Taxes
State Estate Taxes
Even though Federal Estate Taxes are only a concern of the rich (11.4 million in assets are exempt from Federal Estate Taxes, or 22.8 million for a married couple) bear in mind that State “Estate Taxes” are still demanded in 12 states, and the District of Columbia – according to The Balance.
Some states begin to levy estate taxes on inhabitants who die with around 1 million in assets – and with housing values what they are today – thousands and thousands of aging taxpayers will fall into this category.
State Inheritance Taxes
Some states also impose Inheritance Taxes on most heirs. Though many states are relaxing their estate tax guidelines, according to The Balance, at least 6 states will exact estate taxes when moderately well-off residents die.
The state-by-state rules vary when it comes to inheritance taxes, with the top rates usually around 15%-18%. Some offer exemption amounts (for example, the first $40,000 of inheritance value passed on to a son or daughter is exempt in Nebraska).
States may also have sliding tax rates based on the beneficiary’s relationship to the decedent. For example, in Nebraska, an immediate family member will only pay a 1% inheritance tax after the exemption amount, while a non-related friend would pay 18%.
In either case, a Life Insurance policy can be the perfect solution so your heirs won’t be forced to sell off your assets quickly to meet estate tax or inheritance tax obligations.
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